The Changed Estate Planning World

March 19, 2015 | Roger A. McEowen


2013 marked the beginning of major changes in the estate planning landscape. While there had been significant changes to the transfer tax system before 2013, particularly with respect to the changes wrought by the Economic Growth and Tax Relief Recovery Act of 2001 (EGTRRA), the EGTRRA changes expired after 10 years.  Further extensions of EGTRRA were only of a temporary nature until the enactment of the American Taxpayer Relief Act (ATRA) of 2013 which constituted a major income tax increase, and increased the tax rates on capital gains, dividends and transfer taxes.  ATRA’s changes were of a permanent nature.  Also, the additional 3.8 percent tax on passive sources of income under I.R.C. §1411 that was included in the Patient Protection and Affordable Care Act (Obamacare) which was enacted in 2010 and became effective for tax years beginning after 2012, has important implications for the structuring of business entities and succession planning.  For many retired clients, Obamacare increases their tax burden in a material way. 

For 2015, the ATRA provisions generally make estate planning easier for estates under $5.43 million and over $10.86 million, but complicate matters for estates between $5.43 million and $10.86 million (for 2015).  For these intermediate-sized estates, there definitely is no “one size fits all” estate plan, and income tax considerations and basis step-up concerns now play a key planning role.

The Changed Landscape – 2013 and Forward

Because of ATRA, the transfer tax system is now characterized by four key components:

  • Permanency;
  • Indexing;
  • Unification of the estate and gift tax systems; and
  • Portability of the unused portion of the applicable exclusion at the death of the first spouse – known as the “deceased spouse’s unused applicable exclusion amount” (DSUEA)

Other changes that influence estate planning beginning in 2013 include:

  • An increase in the top federal ordinary income tax bracket to 39.6 percent;
  • An increase in the highest federal long-term capital gain tax rate and “qualified dividend income tax rate to 20 percent;
  • The 3.8 percent net investment income tax (NIIT) of I.R.C. §1411;
  • A decrease in the estate tax burden combined with an increase in the income tax burden for individuals and trusts;
  • For agricultural estates, land values more than doubled from 2000 to 2010, and continued to increase post-2010.  From 2009-2013, the overall increase in agricultural land values was 37 percent.  National Agricultural Statistics Service Land Values 2012 Summary, Cornell University, current through August 2, 2013.  In the cornbelt, from 2006-2013, the average farm real estate value increased by 229.6 percent.  Id.  During that same timeframe, the applicable exclusion increased 262.5 percent.  This all means that even with the increase in the applicable exemption to $5.43 million (for 2015) and subsequent adjustments for inflation, many agricultural estates still face potential estate tax issues;

Note:  Agricultural land values have moderated somewhat most recently.  In the Seventh Federal Reserve District (Iowa, most of Wisconsin, the northern halves of Illinois and Indiana, and the entire state of Michigan), there was a three percent increase in agricultural land values for the second quarter of 2014 (compared to the same timeframe in 2013) and a once percent increase from the first quarter of 2014.  Federal Reserve Bank of Chicago, The Agricultural Newsletter, No. 1965, August 2014.  But, agricultural land values may have plateaued.  Very few agricultural bankers believed that land values would increase during the third quarter of 2014, and the 2014 Iowa land value survey revealed that Iowa farmland values dropped 8.9 percent for the entire year. 

  • State-level estate tax issues.  At the time of enactment of EGTRRA in 2001, practically every state imposed taxes at death that were tied to the federal state death tax credit.  Since that time, however, the federal state death tax credit has replaced with a federal estate tax deduction under I.R.C. §2058 and, presently, only 19 states (and the District of Columbia) imposed some type of tax at death (whether a state estate tax or a state inheritance tax).  In those jurisdictions, the size of the estate exempt from tax (in states with an estate tax) and the states with an inheritance tax have various statutory procedures that set forth the amount and type of bequests that are exempt from tax. 

Focusing Estate Planning Post-2012 

The key issues for estate planners now include the following:

  • How the client is expected to live;
  • Whether the client’s lifestyle is anticipated to remain the same;
  • The potential need for long-term health care and whether a plan is in place to deal with that possibility;
  • The size of the potential gross estate;
  • Obsolete nature of pre-2013 common estate planning techniques, including having the predeceased spouse’s exclusion amount pass to a family trust;
  • The type of assets the decedent owns and their potential for appreciation in value;
  • For farm estates, preserving the eligibility for the estate executor to make a special use valuation election;
  • For relatively illiquid estates (commonplace among agricultural estates), preserving qualification for various liquidity planning techniques such as installment payment of federal estate tax and properly making the election on the estate tax return;
  • Whether a basis increase at death will be beneficial/essential.  If so, it is likely that the common pre-2013 formula clause language of wills and trusts is no longer the preferred approach.
  • Where the decedent’s resides at death (because of the level or existence of state income tax):
  • Where the beneficiaries presently reside and whether they are likely to move;
  • If the decedent has a business, whether succession planning is needed;
  • Entity structuring, whether multiple entities are necessary, and the income and self-employment tax issues associated with multiple entities;
  • For agricultural clients, the impact of farm program eligibility rules on the business structure;
  • Asset protection strategies; 
  • General economic conditions and predictions concerning the future.  For agricultural clients, land values, and commodity prices and marketing strategies are important factors to monitor.
  • Whether to utilize a residuary bequest to the surviving spouse in along with a family trust where the family trust is funded if the surviving spouse makes a qualified disclaimer.

Portability. Portability of the deceased spouse’s DSUEA has become a key aspect of post-2012 estate planning.  The surviving spouse’s applicable exclusion amount is tied to the DSUEA of the surviving spouse’s last deceased spouse.  The applicable exclusion amount available to the surviving spouse’s estate includes the surviving spouse’s basic exclusion amount plus the DSUEA of the last deceased spouse of the surviving spouse.  The DSUEA is the lesser of the “basic exclusion amount” or the excess of the applicable exclusion amount of the last deceased spouse of the surviving spouse, over the amount with respect to which the tentative tax is determined under I.R.C. §2001 on the decedent’s estate. 

The portability election must be made on a timely filed estate tax return (Form 706) for the first spouse to die.  That’s the rule for nontaxable estates also, and the return is due by the same deadline (including extensions) that applies for taxable estates. The election is also revocable until the deadline for filing the return expires.  Thus, the election is automatically made if Form 706 is filed (for a taxable estate of the first spouse to die and unused exclusion exists) unless the box in Section A of Part 6 of Form 706 is checked to opt-out of portability.

The regulations allow the surviving spouse to use the DSUEA before the deceased spouse’s return is filed (and before the amount of the DSUEA is established).  However, the DSUEA amount is subject to audit until the statute of limitations runs on the surviving spouse’s estate tax return. This apparently means that any documents that are relevant to the calculation of the DSUE amount, including the estate tax (and gift tax) returns of each deceased spouse can be examined.  Thus, a surviving spouse will need to retain all relevant documents necessary to substantiate the DSUEA amount.  However, the use of a traditional bypass/credit shelter trust arrangement without utilizing portability of the DSUEA avoids this concern.

The temporary regulations do not address whether a presumption of survivorship can be established.  In simultaneous death situations, if survivorship can be established presumably in accordance with state law) the “surviving spouse” could use the DSUEA of the other spouse. Thus, in certain simultaneous death situations where the “wealthier” spouse survives, that spouse could use the DSUEA from the less wealthy spouse. Alternatively, property could be transferred via a qualified terminable interest property (QTIP) trust to the less wealthy spouse for the benefit of the wealthier spouse’s children.  The goal of sheltering the DSUEA of the less wealthy spouse would be sheltered in either of those situations.

The New Planning Emphasis – Income Tax

The biggest change in emphasis for estate planning post-2012 is the shift from a focus on estate tax minimization to income tax planning and management.  This all means that the general focus for most clients will be preservation of the applicable exclusion amount and inclusion of assets in the decedent’s gross estate.  Such a strategy yields a basis increase in the decedent’s assets in the hands of the heirs and, for the vast majority of estates, no estate tax implications.  Thus, lifetime gifting is much less of an emphasis than it was pre-2013.  Likewise, any technique that minimizes the use of the applicable exclusion is favored – such as grantor retained annuity trusts (GRUTs) and intentionally defective grantor trusts (IDGTs).  Indeed, in 2008, the IRS ruled that a grantor’s retained power to substitute assets of equivalent value in a non-fiduciary capacity will not trigger estate tax inclusion if adequate safeguards are present to make sure that the value of the assets put into the IDGT are equal to the value of the assets coming out of the IDGT.  So, high basis assets could be put into the trust and low basis assets could be pulled out.  There would be no inclusion in the decedent’s estate of the high basis assets (which is good from an estate tax standpoint and of little concern from an income tax standpoint because of the existing high basis) and the low basis assets would be included in the estate and get a basis adjustment to fair market value when the decedent dies. 

From an entity planning standpoint, partnerships and limited liability companies (LLCs) provide the greatest flexibility to manage income tax basis.  For example, if succession planning is necessary in the context of a family business, a partial liquidation of partnership assets could be done for a senior family member coupled with an I.R.C. §754 election.  This allows income tax basis to be “stripped” from the assets that are distributed and allocated to the partnership property that remains.  The senior family member would now have assets with no basis that they could hold until death when they would receive a new basis at death in the heirs’ hands.  The “manager-managed” LLC with bifurcated interests can also be an excellent entity to minimize both self-employment tax and the impact of Obamacare’s I.R.C. §1411 tax.  For farm clients, a general partnership with LLCs as members can maximize farm program benefits under the payment limitation rules and the Farm Service Agency attribution rules.

To ensure inclusion in the gross estate (assuming the estate size is under the applicable exclusion level at death), wills and trusts now commonly include a provision that gives an independent trustee (or a trust protector) the power to grant a general power of appointment to the beneficiaries.  This causes the assets subject to the power to receive a new income tax basis at the time of the beneficiary’s death.  Existing trusts can be modified (or decanted) to get this result, if desired.  Numerous states in recent years have modified their state laws to allow decanting.  Practitioners will have to determine whether a particular trust is eligible for decanting, and the possibility of doing so under state law.

Post-2013, the state of residence has taken on greater importance in the planning process.  Several states have no state income tax, and most states don’t have any state-level taxes at death.  A few states have neither a state income tax nor state level death taxes.  Other states utilize community property which will ensure a “double basis step-up” at death automatically at the time of the first spouse’s death.  Conversely, some states don’t have community property, and have high income taxes and impose taxes at death.      

Handling Portability

Portability, at least in theory, can allow the surviving spouse’s estate to benefit from basis “step-up” with little (and possibly zero) transfer tax cost. While traditional bypass/credit shelter trust estate plans still have merit, for many clients (married couples whose total net worth is less than or equal to twice the applicable exclusion), relying on portability means that it is not possible to “overstuff” the marital portion of the surviving spouse’s estate.  This could become a bigger issue in future years as the applicable exclusion amount grows with inflation, this strategy will allow for even greater funding of the marital portion of the estate with minimal (or no) gifts.  But, a key point is that for existing plans utilizing the traditional bypass/credit shelter approach, it is probably not worth redoing the estate plan simply because of portability unless there are extenuating circumstances or the client has other goals and objectives that need to be dealt with in a revised estate plan.

For wealthy clients with large estates that are above the applicable exclusion (or are expected to be at the time of death), one planning option might be to use the DSUEA in the surviving spouse’s estate to fund a contribution to an IDGT.  The DSUEA is applied against a surviving spouse’s taxable gift first before reducing the surviving spouse’s applicable exclusion amount. Thus, an IDGT would provide the same estate tax benefits as the by-pass trust would have, but the assets would be taxed to the surviving spouse as a grantor trust. Therefore, the trust assets would appreciate outside of the surviving spouse’s estate.

Note: Given that income tax basis planning is (generally) of greater importance post-2012, utilizing portability will take on comparatively less importance in community property states because of the basis step-up that occurs on the death of the first spouse. 

As a general observation, a traditional bypass/credit shelter estate plan will generally be better than a standard plan that utilizes portability.  The DSUEA amount is not indexed for inflation and will not keep pace with asset growth occurring after the first spouse’s death.  Thus, the longer the surviving spouse lives, the more effective a bypass/credit shelter trust estate plan will be.  Also, portability provisions do not apply to the GSTT exemption, and states that have an estate tax that is not coupled with the federal provisions may not recognize or apply portability when applying the state’s taxes imposed at death.  In addition, there may be non-tax reasons to stick with the traditional estate plan such as asset protection, asset management and the ability to limit transfers by a surviving spouse.  This last point could be particularly important if children from a prior marriage exist, or there are concerns about a remarriage by the surviving spouse.  The DSUEA also doesn’t apply for state estate tax purposes, and many states that have death taxes have an exemption level that is lower than the federal exclusion.

Other benefits of the traditional credit-shelter bypass approach over simply relying on the DSUEA is that any unused DSUEA derived from a first deceased spouse could be lost to the extent it is not utilized before the surviving spouse remarries and outlives the subsequent spouse. This would be the result even if the surviving spouse’s second spouse used all of the exclusion or the election was not made in the second surviving spouse’s estate.  If there are hard to value assets, a credit shelter trust can keep those assets out of the estate and avoid an IRS valuation challenge. 


The estate planning “game” has definitely changed post-2012.  Now, for most clients, income tax issues predominate rather than estate tax planning.  That has numerous implications for planners to take into consideration without forgetting basic estate planning concepts and essentials that every client needs.